Cryptocurrency and the blockchain have brought about a number of useful technological advances, but one of the most interesting of these advancements is smart contracts. A smart contract can add endless functionality to blockchain projects, and they have the ability to change the way that people do business every day.

What are smart contracts though? How do they work? In this article, we’ll be exploring them and you’ll learn how they apply to cryptocurrencies.

What is a smart contract?

A smart contract is more or less an agreement between two parties. However, thanks to the blockchain this agreement can be trustless. This means that the agreement can function automatically based on certain triggers without the need for it to be managed by a third party.

This provides many options for legal documents that can be created without expensive legal council or courts to oversee them. Smart contracts can be used to exchange money or property when certain events transpire.

How does cryptocurrency smart contract work?

Individuals interested in creating a smart contract must first find a network upon which they can build their contract. Once a suitable option is found they must then set the parameters of the contract. A contract can trigger on different variables related to things like a change in the value of an asset.

The parties involved can then submit their funds to the crypto smart contract, and they will be held in escrow. Depending on how the event plays out, the smart contract can then transfer the escrowed funds to the correct party.

What can smart contracts do?

There are many different purposes which smart contracts can accomplish. However, some of the most obvious cases are for legal documents, the registration and transfer of property, insurance policies and events based wagering.

Many of these projects are actually already in production, and in some cases, you can take advantage of blockchain smart contracts which fulfill these purposes right now.

Augur, for example, allows people to use a decentralized, smart contract-based system participate in prediction markets. You can create a market for literally any event and know that your wagers will be fairly paid if you’re correct thanks to smart contracts.

Cryptocurrency smart contract example

Jimmy wants to create an insurance policy for one of his investments. He decides that the best way to do this is to use smart contracts. He uses an Ethereum based platform that will help him to create a smart contract for this purpose.

Another party takes him up on this offer. They decide that if the price of Ethereum goes below a certain amount that the insurance payout will be sent to Jimmy’s wallet. If this threshold is not reached, then the other part will claim the escrowed fees for establishing the policy.

Some time goes by, and the price of Ethereum drops. Jimmy’s contract activates, and the Ethereum is sent to his wallet. This hedges his investment, and Jimmy ends up not taking a loss on his investment thanks to his insurance policy.

Benefits and issues of a smart contract

Smart contracts offer a fascinating new opportunity to take advantage of the blockchain. Users can benefit from decentralized agreements using these protocols and use them in many different industries to create legal documents without a third party.

While this is great, they do have some issues as well. For starters, it’s questionable whether a smart contract would hold up as an agreement in a court of law if you needed to actually sue over it. It’s also near impossible to change them if you make a mistake because the blockchain is forever.

Smart contract platforms

While Ethereum is the most popular and well known smart contract platform, there are also a number of others, including systems which are actually built on Ethereum itself. These include popular platforms like Neo, Bitshares, Cardano, Counterparty, and Waves.

When and where is a smart contract executed?

Just like other cryptocurrency transactions, a smart contract transaction must be included in a block. Once it’s added to a block by a miner it can be verified and then processed by the blockchain. All data for your smart contract will be stored on whatever base blockchain you are using to create is such as Ethereum or Neo.

How to create a smart contract?

Creating a smart contract on your own requires a little coding knowledge, but if you’re keen to try then Ethereum does offer a ton of help in this department. They’ve got some great tutorials to help you get started.

However, if you need a smart contract for a specific purpose then it might be better to use a platform that’s matched to your needs. This way you can still take advantage of smart contracts without any coding knowledge.

Can it be changed or deleted?

Once your contract is submitted it can’t be changed. Otherwise, it would not work for honoring an agreement between parties. If you really need to change a smart contract, then in most cases you’ll need to change how other smart contracts interact with it. This means you could essentially create a new smart contract to perform your desired functions based on what the original contract already does.

Can it be hacked?

There are bugs in all software and cryptocurrency smart contracts are no exception. Exploits are always a possibility, and If the code is not properly audited it can have disastrous consequences. However, malicious code inserted by the developer is also a problem, and you should be careful what smart contracts you trust.

Smart contract without blockchain

The ledger is an important factor in managing smart contracts. It takes care of the storage of information needed for the smart contracts to operate. Without the ledger, smart contracts would not be able to function.

Smart contract vs DApp

A DApp is more complex than a smart contract. While decentralized applications may use many smart contracts, they’re part of a larger peer to peer network that is meant to accomplish a goal. Smart contracts are simply self-executing agreements, and they can exist within or outside of a DApp.